Peter Freire, CEO, Institutional Limited Partners Association (ILPA) (page 245)
● GP-led Liquidity Solutions
Francois Aguerre, Partner, Co-Head of Origination, Coller Capital (page 259)
● CPPIB's Partnership Centric Approach to Private Equity Investing
Julie Gray, Senior Principal – Investment Partnerships (Funds, Secondaries and Co-Investments), Canada Pension Plan Investment Board (CPPIB) (page 275)
● Listed Private Equity Funds: Is the Market Missing an Opportunity?
Emma Osborne, Head of Private Equity Fund Investments, Intermediate Capital Group plc; Mark Florman, Chairman, LPEQ (page 286)
● FX: Hedge or Hope?
Rob Ryan, Market Risk Manager, Baring Private Equity Asia (page 297)
● The Importance of the Discount to Maximize Return: Myth or Reality?
Daniel Dupont, Managing Director, Northleaf Capital Partners (page 304)
Henry R. Kravis, Co-Chairman & Co-CEO of KKR kindly agreed to write the foreword for this book and we appreciate his thoughtful contribution on the evolution of private equity over the years.
The views expressed in the guest comments are the opinion of the respective author and not necessarily that of their firms and organizations.
FOREWORD
Henry R. Kravis, Co-Chairman and Co-CEO of KKR
What is private equity? Given you're reading this book, I'm certain this is a question you'd like to have answered.
To define the asset class properly is not as simple as looking it up in a dictionary or conducting a quick search on the internet. To do so would give you some version of private equity is capital that is invested privately. Not on a public exchange. The capital typically comes from institutional or high-net worth investors who can contribute substantially and are able to withstand an average holding period of seven years.
But private equity is so much more than its literal definition.
The way I would describe private equity, or PE, today is an asset class delivering market-beating investment returns that has grown college endowments and enhanced the retirement security of millions of pension beneficiaries, including teachers, firefighters, police and other public workers. Just as important, private equity does this by helping companies grow and improve, starting from day one of an investment.
Different firms approach this in different ways, but consistent among them is the first enduring principle of private equity: alignment of interest. This refers to alignment between a company's management and the firm investing in it, but it also means alignment between the firm investing and its own investors.
At KKR, once we make an investment, we work with a company's management team to improve the balance sheet, margins, operations, and, importantly, their topline. These actions may seem obvious steps in how to create successful companies today, but when George Roberts, Jerry Kohlberg and I co-founded KKR a little over 40 years ago, they were not.
In the '70s and ‘80s, companies were less concerned with these efficiencies, perhaps because management was focused on other things. To help solve for this, when we were getting started, we instituted management ownership programs, a concept that was not typical in those days. Running a company as an owner unlocks value and this alignment of interest impacts company profitability substantially. I remember a board meeting at one of our investments in the ‘80s, a business in the oil and gas industry, where management recommended a $100 million oil exploration budget. Our first reaction was that they must be quite optimistic about their prospects to risk that much of the shareholders' capital. We pointed out to them that as shareholders who owned 10 % of the company, they were putting $10 million of their own capital at risk. Moments later, management decided to reconsider the budget. One month later, the exploration budget had been cut in half, and they were acutely more focused on the results of each and every drilling site.
The opportunity to improve companies, the ability to have an alignment of interest with management and us being the shareholders with long-term, patient capital – to me, these are the hallmarks of private equity.
And while we have been focused on delivering exceptional long-term investment returns from the outset, private equity has evolved quite a bit since we started out four decades ago.
After leaving Bear Stearns to start our own firm, we had $120,000 between the three of us – $10,000 each from George and me, which was about all we had at the time, and $100,000 from Jerry who was 20 years our senior. With $120,000 in the bank, we went to raise our first fund, a $25 million private equity fund. Keep in mind there were no such funds in those days and there was no one doing what is now considered private equity. Given this environment, we had a difficult time raising the $25 million on terms that we felt made sense. So we had a thought: Why don't we go to eight individuals and ask them to put up $50,000 each for a five-year commitment and in return, we'd give them the ability to come into any of our deals. And if they did invest, we'd take 20 percent of the profits – what is known today as carried interest.
How did this happen? George's father and my father were in the oil-and-gas business where, in those days, there was something called “a third for a quarter.” If you had a lease and wanted to drill, you put up 25 percent of the cost and found someone to put up the remaining 75 percent of the cost. Consequently, that person gets a two-thirds interest for what they put down and you get a one-third interest. When applying this concept to our own business, we thought 20 percent was close enough to third for a quarter, and that's still the standard today.
When we first started doing deals, private equity transactions, better known as leveraged buyouts at the time, were in their infancy. The PE industry as we know it was not yet born. In fact, we never imagined we'd ever use the term “industry” when talking about what we do.
Private equity deals looked very different than they do today. The asset class was new, and so too was its level of sophistication. As PE explored elaborate capital structures, new sources of funding, larger pools of equity capital and did so through variable economic conditions, we did not properly explain these complexities – or our mission – to the public. As a result, PE deals became associated with hostile takeovers at the time. Referring to PE as “corporate raiders” or “barbarians,” the public's reaction to the very same question I asked you – what is private equity? – was simply: an investment vehicle to acquire, strip and sell an asset for profit. We never thought of it this way; we were always focused on the opportunity at hand to create value at the companies in which we invested. Nonetheless, we and others did not pay enough attention to communicating this with our various stakeholders.
Looking back 40 years later, this is one of the many lessons, perhaps the hardest, that we've learned along the way. These lessons – and the headlines referencing barbarians that came with them – are not exclusive to KKR. The experiences of the early days of PE served as a catalyst for transformation of the entire PE industry.
I think it is safe for me to speak on the industry's behalf when I say we have learned there is so much more to investing than buying low and selling high. As my colleague Bill Cornog will expand upon in Chapter 13, we've learned to think of ourselves as industrialists. When we buy a company, we ask ourselves: what can we do to make it better? How can we create value? What constituents should we be mindful of and will factor into a good outcome for everyone?
At KKR, key to answering these questions is the development of what we call 100-Day Plans. These plans are put into place as soon as we make an investment. That means we hit the ground running from the day a transaction closes. Our goal is to focus, with a sense of urgency, on the creation of value. As part of this process, we establish upfront operating metrics. These can often reveal underlying problems with a business before those problems can be seen in the financial data. In this way, we can make difficult operational and personnel decisions